When CFA Institute and a member society, CFA Society Singapore, recently convened a panel of industry practitioners to examine market fraud in the Singapore equity market, what truly amazed me was the number of activities currently overseen by the local regulators’ market surveillance team.

The expert panel featured the chief regulatory officer from Singapore Exchange (SGX), an executive director from a local brokerage, a local independent director, an international lawyer specializing in market-fraud class-action lawsuits, and a retail investor.

The panel initially discussed the definition of market fraud, before going on to explore its origins and what can and should be done to minimize its detrimental impact on market integrity.

Let’s start with surveillance. For its part, SGX uses a surveillance system that triggers real-time alerts. Surveillance analysts review company disclosures, macroeconomic factors, and industry developments that could explain the trading activity.

On average, about 2,000 alerts are analyzed by the SGX surveillance team every month. Normally, only a handful merit further investigation and even fewer eventually develop into full-blown court cases. Nevertheless, 2,000 alerts per month translate to 24,000 alerts annually — definitely not an easy feat even if just 1% is worthy of further investigation.

Although SGX has a market surveillance team in place, it does not have the power to seize documents or interrogate suspicious individuals. That power rests solely with the relevant statutory authorities.

It is not difficult to see that enforcement is indeed a tough and tedious job for SGX to undertake. Would it not be better to remove SGX’s “regulatory” responsibilities and render it a purely commercial entity? After all, that has happened in Australia, where the focus of the Australian Securities Exchange (ASX) is entirely commercial while the Australian Securities and Investments Commission (ASIC) solely regulates.

At first glance, it is naturally appealing to segregate commercial affairs from regulatory duty. After all, this would, once and for all, eliminate perceived conflicts of interest. Upon deeper examination, however, there are two reasons why such a move might be detrimental.

Firstly, it is the bourse that has all the tick-by-tick transaction data essential to investigative work. Unlike staff at the exchange who are dealing with the data on a daily basis, it would be considerably harder for an external regulator to carry out this type of surveillance.

Secondly, it is in SGX’s very own interest to ensure that fairness is optimized within market transactions. As a bourse, it derives revenue from the exchange fees that it collects for every transaction. A market that is heavily tainted by insider trading and stock manipulation would gradually lose the trust of potential investors. Henceforth, its trading volume likely would steadily decline with time. If that were to occur, who has the most to lose? Quite obviously, the answer is SGX.

As an analogy, SGX’s motivation to clean up abnormal trading activities is tantamount to a casino’s desire to ensure there is zero trickery at its gambling tables. In other words, there is an inherent motivation (instead of perceived conflict of interest) for SGX to maintain a level playing field for all investors.

The next question to ask is why SGX’s surveillance activities and regulatory support activities are not well known to various stakeholders at large.

The answer probably lies with the paternal stance adopted by regulators during the inception stage. In Asian culture, governmental authorities are always being regarded as the “fatherly figures.” A father is assumed by his children to be doing the right thing at all times, and no questions whatsoever should be asked. In short, the father typically does not see the need to explain to his children why and what he is doing, and for whom.

Today, however, as we have transcended a prescriptive-based regulatory framework to one grounded on caveat emptor (or “buyer beware”), it is essential for regulators to adopt a more consultative approach in enforcement and policy formation.

There are many advantages for regulators to adopt this consultative approach.

Firstly, getting other stakeholders to understand what regulators are doing, can do, and will be doing renews confidence in market integrity. Indeed, if stakeholders have a say in policy formation and are more informed, they become less vulnerable to market gossip as well as more adept at interpreting corporate announcements. Only then will the caveat emptor principle be meaningful and practical. In other words, you need to “arm” market participants before they are ready to protect themselves.

Secondly, external stakeholders can provide insightful market information to regulators, provided of course they are aware of the proper channel to voice their feedback. As active participants in the capital markets, external stakeholders such as fund managers, analysts, and perhaps even retail investors are in an ideal position to provide regulators with frontline intelligence that I suspect regulators are desperately in need of receiving.

Thirdly, mass media is naturally biased towards reporting sensational events, and where capital markets are concerned, that would typically include market frauds involving astronomical amounts of money, insider trading by prominent figures, and the sharp decline or collapse in share prices.

Fewer media outlets dutifully report on the robust background work undertaken by regulators. Henceforth, it remains the duty of regulators themselves to make known to the world what they are doing and what they hope to change. It’s time to stop working silently.

I quite agree with the point of paternal stance. Especially in China, governmental authorities are always considered to be the winner, while instead of questioning it more people tending to secretly gossip. Consultative approach is a good posture for regulators to build up their image of fair and motivate the initiative of stakeholders. I think giving enough education to stakeholders in this aspect is a precondition and it might be a new challenge to regulators and mass media. It might also help to stop working silently.
In addition, I have a problem about SGX. In fact, SGX cannot seize documents or interrogate suspicious individuals. This fact seems can weaken the power of SGX and impede further investigation. If stakeholders also think so, will they lose confidence in SGX so that what SGD do would become indifferent to them? I think it might also explain why SGX’s surveillance activities and regulatory support activities are not well known to various stakeholders. —Because they themselves don’t care about it…… What if give such power to SGX?

Thanks Yirong for your active participation. I am definitely with you in regards to seeing a more consultative approach being adopted by regulators during policy formation. That said, it would also be crucial for stakeholders (fund managers, retail investors, corporate people) to play a more active role in feeding regulators with on-the-ground information as well as opinions. Ultimately, it has to be one for all and all for one.

Hi, agree that the regulators have failed to convince retail investors that they are “watching their backs” especially in light of the recent ABL penny stock saga. It is definitely in their interest to do so considering the dismal retail participation in local equities.

SGX / MAS has since announced some measures to beef up confidence that would take place in stages including imposing a min trading price at 0.20 cents to deter over speculation ( some is still good for liquidity ), 5% collateral requirement for trading to mitigate excessive leverage trading, Short position reporting requirements to further enhance transparency of short selling activities and establishing independent committees that will strengthen their listing process and improve transparency of its disciplinary process amongst others.

They are doing ok in derivatives but their securities revenue have been declining with no immediate obvious signs of a reversal so the above steps would hopefully go some way to address some of their concerns. Only time will tell , lets see .

Hi Joshua, glad to see your interesting comments again. There have indeed been quite a few rule-changing events happening in the Singapore equity market lately. For one, regulators are intensively hearing the voice of stakeholders and actions are definitely in the pipeline. Do bear in mind, however, that there can be no-one-size-fits-all solution. Any reform or structural change would please some people and at the same time generate resentment in others. The crux lies in maintaining a delicate balance between overall reward and risk. And as you have rightly pointed out, only time will tell.

Information gap between regulators and stakeholders doesn’t improve investors confidence despite the fact that market participation is driven by speculative motives. increasing stakeholder involvement through consultations will be a step in the right direction.

Thanks Laimo. Stakeholder participation in policy formation by responding to consultation papers is definitely an important feature in capital market regulation. And from what we’ve observed thus far, the percentage of responses coming from the retail investor category is on the rise, which means more minority voices will be heard. Please continue to come back to us with more comments and insights from your perspective, and rest assured that in one way or another, your opinion will be heard.

I believe market fraud is happening in every equity market in the world. Could you provide some examples on how and what prevention efforts have been taken by other country’s regulator or security exchange on this?

Hi Eric, there are two sides to your queries. Firstly, enforcement – the typical market surveillance activities undertaken by the typical bourses. Secondly, prevention – the bulk of which comes from investor education. For the former, it is the knowing that someone out there is “watching you” that discourages potential market manipulators. For the latter, investor education would include getting the masses to understand how the company operates, the typical principal agency conflict, interpretation of financial analysis, and the deciphering of underlying messages behind disclosures. Regulators around the world have been for decades trying to improve the awareness among retail investors so that they can remain rational and not be susceptible to vicious attempts at manipulating the capital markets. The effect has thus far been lukewarm given that active learning is not a natural component of human nature.